Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?

@article{Wachter2008CanTR,
  title={Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?},
  author={Jessica A. Wachter},
  journal={AFA 2011 Denver Meetings (Archive)},
  year={2008}
}
Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the… Expand
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